30 April 2014: this is the deadline that the Financial Conduct Authority (FCA) has set for firms to demonstrate compliance with the Risk Mitigation Techniques requirements for non-centrally cleared derivatives set out in the European Markets Infrastructure Regulation (EMIR). This leaves firms just over two weeks not only to ensure that they have processes and controls in place to comply fully, but also that those processes and controls are documented to a standard that will satisfy the regulator. Many firms may be failing to meet one or even both of those targets.

The FCA will fully integrate these new requirements into its supervisory activities through its Firm Systemic Framework. Its supervision of EMIR compliance will focus initially on the Risk Mitigation Techniques which came into force in March and September 2013; the regulator expected firms that were unable to comply with these requirements immediately to have a detailed and realistic plan to achieve compliance within the shortest time frame possible.

In addition, the FCA is likely to focus thereafter on other requirements such as: reporting of derivatives contracts to Trade Repositories; readiness for reporting of mark-to-market exposures to Trade Repositories; and the clearing obligation.

What are the risk mitigation techniques?

EMIR introduced the following risk mitigation techniques to reduce the operational risk of bilateral (non-centrally cleared) OTC derivative transactions:

  • Timely confirmation (starting March 2013): Counterparties must document the agreement of all the terms of a contract;
  • Daily valuation (starting March 2013): Counterparties must evaluate their contracts on a daily basis using a market-to-market method. Where this method cannot be used, a mark-to-model approach must be applied and the method must be calibrated and validated;
  • Portfolio reconciliation (starting September 2013): Counterparties must reconcile the key terms (e.g. valuation, asset class, underlying, etc.) of each trade with each counterparty to identify any discrepancies;
  • Dispute resolution (starting September 2013): Counterparties must have agreed procedures and processes to identify, record and monitor disputes relating to contract recognition or valuation and exchange of collateral, and to resolve disputes in a timely manner; and
  • Portfolio compression (starting September 2013): When counterparties have at any given time at least 500 trades outstanding between them, the counterparties must assess whether compression of the number of trades is appropriate (i.e. to achieve a risk exposure reduction).

''If we have those processes in place already, why does my firm need to worry about these EMIR obligations?''   

Having these processes 'up and running' is a starting point but firms need also to have them properly documented and evidenced in line with the latest EMIR requirements. Deloitte's experience in helping firms assess the impact of EMIR on their business models and implement strategies, systems and controls to achieve compliance, has given us a detailed insight into the challenge firms often face in complying with the EMIR Risk Mitigation requirements. Some firms already apply processes and controls such as valuations and portfolio reconciliations, but have failed to check that those processes meet the standards and frequencies required by EMIR. Moreover, firms often have all or part of these mitigation processes in place but unfortunately few are properly documented in the perspective of the EMIR obligations. In order to be able to demonstrate compliance to FCA, firms should also have:

  • clear processes to address each requirement;
  • well documented procedures, including defined roles and responsibilities; and
  • formalised agreements with your counterparties for each requirement, where necessary. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.